Good corporate governance is essential to help ensure transparency in the conduct of private business. By instigating effective controls and greater transparency in their actions, companies can help address the supply side of corruption, in which money, gifts or other forms of inducement are provided or promised to achieve certain advantages. Transparent corporate rules and practices provide a rational base on which investment and business decisions can be made and save companies resources that may otherwise line the pockets of public officials or corrupt business people. Effective corporate governance will comprise a system of internal controls, checks and balances and independent external verification whereby corrupt activities can be prevented, exposed and sanctioned, thereby minimising risk and enhancing reputation.

Good corporate governance is best understood as a well-functioning system of corporate direction and control. The debate around corporate governance has quickly evolved due to several far-reaching incidents of corporate fraud and collapse. During the 1990s’ stock market bubble, corporate executives used accounting manipulation to inflate profits and enrich themselves by selling huge stock option packages. In recent years, several industrialised countries have also been rocked by scandals involving ‘donations’ by companies to political parties and public officials. In France, for example, the former chairman of oil giant Elf - convicted of misappropriating EUR 180 million worth of company funds - admitted paying EUR 5 million a year to French political parties in order to buy their support (Source: “Gigantic sleaze scandal winds up as former Elf oil chiefs are jailed”, UK Guardian, November 13, 2003 http://www.guardian.co.uk/france/story/0,11882,1083784,00.html).

Good corporate governance is of crucial importance to countering corruption in both developed and developing countries. Where levels of corruption in the public sector are high, it is not the most competitive companies that succeed but, rather, those that can afford to bend the market and regulatory system in their favour. Without fair competition, international investors prefer to direct their investment elsewhere or to demand higher returns to mitigate the increased risk of doing business. Higher national standards of corporate governance can significantly increase trust among international investors and lenders, thus improving the international competitiveness of national economies. Good corporate governance at home and abroad can also help improve conditions for small or local companies in developing countries who cannot afford to compete with foreign businesses that choose to engage in unethical practice.

Though its potential impact in reducing corruption is great, critics claim that corporate governance is sometimes seen in the private sector as a formal “box-ticking exercise” - devoid of any underlying commitment to transparency and accountability. There is a danger that corporate governance can become a smoke-screen behind which corrupt practice continues unabated. Voluntary approaches to enhancing corporate governance should not, however, be automatically equated with ‘box-ticking’. Indeed, by strengthening private sector ‘ownership’ of governance measures, such approaches often provide avenues for progress where binding regulations do not.

A reliance on non-binding initiatives alone, however, risks allowing some companies to choose only the most unchallenging governance measures. Continued engagement with investors, strong public awareness, action by civil society and a strengthening of regulatory bodies are all necessary to realise the potential of corporate governance to help counter corruption.

Corporate governance refers to the system by which a corporation is governed and administered. It relates both to the roles of different actors in the system, and to its internal and external checks and balances. There are two broad views of corporate governance. The first focuses on the relationship between company owners and managers; the second on the wider set of relationships between owners and company stakeholders, including shareholders, employees, local communities and NGOs.

The need for corporate governance systems arises in relation to the separation of ownership and management of corporations. Public companies are characterised by a separation of roles between those who own the company (i.e. shareholders or investors) and those who direct its economic fortunes (i.e. managers). The main aim of corporate governance systems in public companies is to create a balance of power between owners and managers. Corporate governance standards can and should also apply to private small- and medium-sized companies, not least in order to increase their ability to attract external capital.

Corporate governance rules generally set-up a system of institutions that govern the relationship between investors and creditors on one side, and managers on the other. They ensure the disclosure of core financial and business information to shareholders and, often indirectly, to the public. Such transparency provides for competition that is based on fair and responsible practices.

In the corporate governance debate, increasing attention is paid to the relationship between managers and stakeholders, the protection of minority shareholder rights and the independent supervision of business activities. The typical corporate governance agenda is illustrated below by the OECD Principles of Corporate Governance - an internationally recognised distillation of current global best practice.

More broadly, corporate governance can be understood as a system whereby written regulations are reinforced by wider ethical standards of corporate behaviour. In this context, corporate ethics programmes provide an underpinning framework for the behaviour expected of individuals within a company. Corporate social responsibility (CSR) programmes, on the other hand, generally attempt to operationalise and implement the idea of corporate responsibility towards various stakeholder groups and in relation to issues of material relevance such as impacts on local communities, human rights and the environment.

Whether understood in a broad or narrow sense, improving corporate governance is key to countering corruption. By providing an effective system of corporate control, good corporate governance provides an essential mechanism for stemming the potential for corrupt practice involving private sector actors.

Despite an increasing realisation of the overall benefits of well-governed enterprises, several factors continue to limit the ability of corporate governance to function to its fullest and therefore serve in the fight against corruption. The most significant challenges to corporate governance as an effective anti-corruption tool are highlighted below.

Under-resourced regulators

Much of the corporate excess of recent years can be traced to an increasing imbalance between the growth of companies, accountancy firms and financial markets on the one hand, and the stagnation or decline of resources available to regulatory bodies on the other. When regulatory bodies cannot fulfil their control function or prosecute incidents of fraud, money-laundering and corruption, companies willing to engage in these activities will not receive appropriate sanction.

In the United States, for example, financial markets grew significantly between 1980 and 2000. At the same time, the resources of the national regulatory body, the Security and Exchange Commission (SEC), stagnated. In 1939 the SEC had 1,700 employees. In 2001, when 2 billion shares a day changed hands, it had the equivalent of 2,936 full-time workers. (Source: Alex Berenson, The Number – How America’s Balance Sheet Lies Rocked the World’s Financial Markets, Simon & Schuster: 2003. For further assessments of various countries’ regulatory systems see the International Monetary Fund: http://www.imf.org/external/np/rosc/rosc.asp)

Profits before values: corporate incentives and cultures

Despite the increasing debate around corporate values and ethics in recent years, the financial bottom line continues to determine the market value of a company and the compensation levels of its senior managers. Maintenance of share price through delivery on profits is the standard against which boards and managers are measured. Incentives such as bonuses or share-options may be offered to those in companies who perform best in these areas.

Directors and executives who embrace the pursuit of profits through corrupt practice send a clear message to their employees and business partners: as long as you are successful and are not caught engaging in corruption, you help the company achieve its aims. In some cases, employees who stretch the limits of legality are not disciplined but are, on the contrary, promoted. In extreme cases, the payment of bribes or other corrupt business activities may be condoned on the basis that they enhance company performance via new lucrative contracts or acquisitions. Alternatively, individual employees may choose to ignore their company’s ethical guidelines and engage in corrupt practice for their own personal gain, thus presenting corporate managers with a risk management crisis.

Uninterested, inactive shareholders

A factor in limiting the effectiveness of corporate governance in curbing corruption is the behaviour of a company’s owners. If shareholders are uninterested in policies against corruption and bribery, managers will be less inclined to address the issue. Though shareholders often find themselves among the victims of corporate corruption (i.e. through reduced dividends, distorted markets and un-competitive companies), institutional investors have largely relied on passive investment strategies, such as index–linked funds, that do not take corporate governance issues into account. Having said this, Socially Responsible Investment (SRI) has, in recent years, become increasingly important in defining institutional investment strategies. SRI benchmarks – such as the UK’s FTSE4Good Global Index – provide investors the opportunity to screen potential investment options according to the ethical performance of companies.

Lack of bottom-up communication

Employees at the lower-levels of company hierarchies often have considerable knowledge about corrupt corporate activities. Though they may be in a position to warn investors and board members, they often refrain from doing so for fear of negative consequences. Within corporations, there is generally a lack of mechanisms that allow employees to circumvent their direct superiors and expose corrupt behaviour in a confidential manner. Consequently, even well-intentioned managers and board members do not receive sufficient or accurate information about the manner in which business is conducted ‘on the ground’. In such circumstances, corrupt behaviour cannot easily be exposed.

Weakness of the board

The role of the board is to set the overall strategy of a company and advise and supervise its management. A particular role is assigned to independent non-executive directors whose task is to ensure that the company is steered in the interests of its owners (i.e. the shareholders) and other stakeholders, particularly with reference to strategy and governance.

In general, however, boards - and, specifically, non-executive directors - seldom contradict management in the absence of crisis. This can be traced to a number of systemic failings: (a) a lack of training on what a directorial post entails, (b) inadequate or distorted information flows that strengthen management’s capacity to set the agenda, (c) a limited pool from which to attract potential board recruits and, (d), failures in obtaining truly independent directors. Unless appropriate anti-corruption practices are in place, boards may not be in a position to investigate or enforce compliance of corporate governance standards.

Lack of reliable audits

Auditors fulfil a crucial corporate governance role by checking financial statements and assuring shareholders, financial markets and - sometimes - stakeholders that a company’s accounts are a fair and accurate reflection of its financial wellbeing. In some countries, auditors are required by law to bring any illegal, fraudulent or corrupt behaviour to the attention of regulators or public authorities.

Audit firms also perform non-audit related advisory work for their clients, often helping them find legal ways to circumvent tax rules. Audit firms can make more money from such advisory work than from the fees they charge for the performance of audits. This has led to perceptions that auditor independence may be compromised by their dual advisory and accounting role.

Concentration in the global audit market - with the “big four” accountancy firms (PriceWaterhouseCoopers, KPMG, Ernst & Young and Deloitte & Touche) conducting the vast majority of audits for multinational companies – is seen to exacerbate the problem of independence. The limited number of firms capable of conducting large and complex audits may, in some instances, lead to cut-throat competition and, potentially, reduced quality of audit work, as firms seek to out-bid their close competitors.

One-size-fits-all governance codes

National corporate governance codes - from Kenya to Indonesia, from Mexico to Italy – apparently indicate that there is broad global consensus on the best way to govern corporations. Common elements include: independent directors; audit, remuneration and nomination committees; external auditors; effective systems of internal control and transparency in company compliance.

Such codes – which are often voluntary in nature – do not, however, always correspond to actual corporate practice. Indeed, the analysis of real decision-making practices in the corporate world and compliance with the spirit of corporate governance standards is still in its infancy. Corporate governance rules that ignore the reality in which companies operate stand little chance of contributing to the fight against corruption.